credit, and thus exceeds voluntary savings" (Haney, 682). Hayek puts an emphasis on the highly technical area of trade-cycle theory after 1931. He concentrates on the "Ricardo effect" in that period. In a boom the rising demand for consumer goods drives up their prices, leading to a fall in real wages. This, in turn, leads to an increase in investment demand, but this is coupled with and eventually offset by a fall in capital: output ratios as real wages fall (Tomlinson, 5).However, Hayek argues that "investment will tail-off in a slump even though profits are rising" (Tomlinson, 5). He relates the Austrian theory of capital to the business cycle in order to show that a rising level of consumption must reduce rather than increase the rate of investment. Hayek shows that A rise in the demand for consumer goods, with money wages and interest rates remaining unchanged, by causing an increase in prices of consumer goods and a decrement of real wages, will lead to a fall in the demand for capital goods thereby causing unemployment (Palgrave, 198). The Ricardo-Hayek effect comes from Ricardo's argument: "a general rise in money wages leads to a substitution of machinery for labor" (Blaug, 571). Hayek thinks that Ricardo's statement is misleading. Hayek, himself, tries to prove that if the relative prices of labor and machines change, a rise in wages will induce substitution of capital for labor, and vice versa. A rise in the ratio of output to input prices increases the annual rate of profit on working capital more than on fixed capital. This induces the firm to invest its liquid capital funds in processes with a high rate of turnover. When the fall in real wages is general, the result is that the average period of turnover of gross investment expenditures in the economy as a whole declines; in other words, the average period of production is shortened (Blaug, 573). According to Hayek, commodity pric...
